Inflation and Deflation - Definition, Types, Causes, and How to Overcome Them

Inflation and Deflation

Inflation and deflation are two things that are often the main topics and affect the financial system of a country as a whole. It can be said that inflation is always associated with increasing prices, on the other hand, deflation is a decrease in the price of goods sold by the public. The increase and decrease in market prices are largely determined by the two things previously discussed.

On this occasion we will discuss a complete review of inflation and deflation, so make sure you read this article to the end. 

Difference Between Inflation and Deflation

  • Inflation is a significant increase in prices due to many factors. However, if the price increase only occurs in one or two products, it cannot be called inflation. Because inflation can be said if there is an increase in the price of a product and it affects the product itself. In this case, we can take an example related to daily needs, such as the price increase which continues to soar as a result of increasing public consumption.
  • Deflation in the economy is a condition in a certain period, which shows a decrease in the price of goods or services in general. Impact on other sectors, such as wages of workers. This deflation occurred partly due to the lack of money circulating in society.

Causes of Inflation and Deflation

Causes of Inflation 

1. Quantity Theory Inflation 

The amount of money in circulation is always related to inflation. The reason is to remember that if the quantity of goods is fixed but the amount of money in circulation is more than twofold, it is not surprising that the price of goods has also doubled.

2. Cost-Push Inflation

Inflation occurs due to an increase in production costs continuously, which is due to pressure on the costs of production factors that continue to rise.

3. Mixed Inflation 

Increase in supply and demand for goods or services, but provision is very limited. So that it causes the supply of goods and production factors to decrease. This type will be difficult to overcome and control when there is a high gap between the two. 

4. Structural Theory Inflation

The cause of inflation is in terms of a rigid economic structure. In this case, the producer cannot prevent the rapid increase in demand due to a surge in population growth. Until finally the demand is not balanced with the existing supply.

Causes of Deflation

1. Decreasing the amount of money circulating in the community

Being in the first position is the reason why deflation occurs. It can happen because many people choose large yields or high-interest rates in the bank. So they use these opportunities to save. 

2. Increasing the number of goods on the market 

It is one of the mistakes of producers who carry out production without proper calculations. It is not surprising that the price of goods decreases because there is less demand compared to the number of goods.

3. Decreased demand for production results

If the products produced cannot be accompanied by an appropriate demand, deflation may occur. So that producer is advised to have the right calculation of the amount of production.

Types of Inflation & Deflation

Inflation Type

1. Creeping Inflation 

As the name implies, it can be said that this type of inflation is characterized by an increase in a low inflation rate. Where the price increases tend to be slow and less than 10% a year.  

2. Galloping Inflation 

It has a rate ranging from 10-30% per year and marked a significant increase in prices in a short time. Its existence is higher than early-stage inflation.  

3. High Inflation 

At this stage, the price of community needs increases significantly and is difficult to control. Covers rates ranging from 30-100% a year, and is classified as heavy 

4. Hyperinflation 

At this stage, a country will feel inflation of more than 100% a year, and it is very much avoided by various parties. Indonesia itself has experienced hyperinflation, in 1998.

Deflation Type

1. Strategic Deflation 

At this stage, strategic deflation occurs due to control policies resulting from consumption symptoms which ultimately lead to an increase in market prices. 

2. Circulation Deflation 

Generally, it occurs because there is a transition from being successful to being decreased. This occurs due to unbalanced production and consumption power. Thus causing market prices to fall and resulting in an economic recession. This is also a result of excessive goods.

Effects of Inflation and Deflation

Inflation Effects

1. Eroding Purchasing Power

This first effect of inflation is just a different way of putting it. Inflation is a decrease in the purchasing power of a currency due to rising prices throughout the economy.
These price changes can be imagined as a result of a surge in the popularity of a product, or a combination of prices from producers. In this scenario, the product price will increase, but it will not affect consumers.  

2. Encourage Spending and Investment 

A predictable response to a decrease in purchasing power is a reduction in the value of cash. So it's better to get rid of your groceries and keep items that might not lose their value.
For consumers, that means filling up the gas tank, filling the refrigerator, buying the next size shoe for the kids, and so on. For businesses, that means making capital investments that, under different circumstances, might be put off until later. Many investors buy gold and other precious metals when inflation starts, but the volatility of these assets can cancel out their isolating benefits from rising prices, especially in the short term. 

3. More Inflation Cause 

Unfortunately, the urge to spend and invest in the face of inflation tends to increase inflation continuously. It even creates a potentially catastrophic feedback loop. Because most people and business people will spend efforts to reduce their time holding their depreciating currency. In other words, the supply of money exceeds demand, and the price of money for the purchasing power of currency is falling at an increasingly fast rate.

Effect of Deflation

1. Decreased Business Income 

In the economy of a country facing deflation, it will drastically reduce the price of the product, which aims to keep making a profit. But of course, if prices go down, income will also decline. 

2. Lowering wages and layoffs 

Not only the economy but also businesses need to find ways to reduce spending, by reducing wages and cutting jobs. This is what will adversely affect the economy as well as many people.

How to Deal with Inflation and Deflation

To overcome the general price increase, several things need to be done:

1. Monetary policy

 All forms of policies in the financial sector, which aim to maintain stability. The government can take steps to reduce the amount of money in circulation, as well as fix the cash supply in banks. Apart from that, it is also necessary to apply a discount policy and an open market operation policy. 

2. Fiscal Policy

Measures to influence government revenue and spending, which affects the inflation rate. Fiscal policy as follows, to save government spending which will later reduce prices. Until increasing the tax rate to reduce the level of consumption.

Efforts to Overcome Deflation

The phenomenon of deflation cannot be taken lightly because it can hamper the economy. However, it can be overcome in the following ways: 

1. Reducing Interest Rates 

With the existing interest rate, people would prefer to keep it to themselves. With a large circulation of money in society, this will increase the number of goods purchased. 

2. Implementing Non-Monetary Policy 

To reduce the rate of deflation, producers must be given restrictions when producing goods or services. So that later the reduction in the number of goods will cause an increase in prices.
Simply put, inflation and deflation are two things that affect a country's financial system as a whole and determine the increase or decrease in the price of an item. So that in this case the government is expected to take the best steps to overcome it.
Inflation and deflation are things that affect a country's economy as a whole and are always associated with an increase or decrease in prices. Since these two things are interrelated it is not surprising that every country is trying its best to overcome this.

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